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Sunday, March 7, 2010

Commercial Real Estate Apocalypse: Destruction

Between 2010 and 2014 $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half of these loans are under water, meaning that the property is worth less than the mortgage. Property values have fallen over 40 percent since their peak in 2007, and they continue to fall every month as we move forward.

The fall in value occured due to an increase in vacancy and a decrease in rents in buildings across the country as the economy deteriorated.

Income Down - Building Value Down

The following chart shows the increased vacancy in all property types:

The following chart shows the falling rent prices in all property types. (Many commercial leases are locked in for long terms so this number will accelerate downward later in the crisis window)

Taken together, these two factors have led to the sharply reduced values of all commercial property as can be seen below:

The impact of commercial real estate losses will be felt most by small and community banks. While these banks packaged and sold most of the residential loans originated to wall street, they kept the majority of the commercial real estate loans on their books.

Only the highest quality of commercial real estate loans were purchased by wall street and packaged into loan pools. This means not only did they keep the majority of the loans on their books, but they kept the more risky loans that were created.

The fact that there is $1.4 trillion in debt that needs to be refinanced over the next few years with most of those properties underwater already seems like an insurmountable task.

However, when you look deeper you can see that the problem is actually greater. The credit market for commercial real estate has dried up completely. The CMBS "loan pool market" that was available from wall street only a few years ago has completely disappeared. Couple that with the fact that banks are severely undercapitalized, and their ability to take on new loans or refinance is essentially non-existent.

This is the reason that the FDIC is going from door to door every Friday night and shutting down banks. We haven't seen anything yet. It is a downward spiral in that the inability to refinance reduces prices further, thus making it even harder for new loans to refinance.

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